German Court Ruling Good For Europe Risk
My Plausible Bear Path yesterday took a dent today with the German Federal Constitutional Court ruling. As in the e-mail that sent out in the immediate aftermath, this ruling was good. There were no real conditions.
The condition is that to expand beyond the current €190 billion would require approval of lower house or something. So it isn’t even that the German liability can’t grow, just that it would require more approvals.
I have to admit that I was a bit shocked how many negative comments there were on my twitter stream right after the announcement. CAPPED! CONDITIONS! NO UNLIMITED BUYING! I was surprised because they were so wrong. This case was about the ESM and not the ECB. So the ECB can still be “unlimited” which I suspect means no preset limit as opposed to infinite, anyways.
At €500 billion does the ESM have enough? I think for now that is plenty so long as combined with efforts from the ECB.
The wildcard remains Rajoy who seems unwilling to ask for a bailout. Either he is going to be given terms that are so good, like re-affirming commitment to the Fiscal Compact, that he can’t help but ask, or he will let markets take a leg lower and push him.
Under no circumstances, will Spanish yields remain low for long if Spain does not embrace a plan. At this stage the EU will not use ESM money for Spain until they accept a full package. Again, the conditions to get a full package may be small, but Spain needs one.
German Court Ruling Bad For Big Balance Sheet QE3 Hopes
With Europe finally coming up with something that resembles a plan, it will be hard for Bernanke to justify QE. He has been adamant that problems in Europe have been a big concern. It would be bordering on irresponsible to flood liquidity into the U.S. until he sees how the world markets (not just for stocks, but for bonds and commodities too) react to the latest actions in Europe.
He runs real risk of letting loose liquidity at a time when the attention should remain on Europe and what they manage to accomplish. He has to contend with the fact that fiscal policy here remains on hold and that by easing pressure, he delays long term solutions.
I expect a very dovish statement, lots of hints and promises, but limited action.
Ships Passing In the Night
I have been on the re-coupling theme for some time. For the first time since I started on that thesis, I can actually see that not only have the “two ships” of the U.S. and Europe been approaching each other, but they may have even passed.
- Dysfunctional Governments that Can’t Accomplish Anything. The U.S. may now be the reigning champion. It is pretty amazing that Europe has been able to come so far. Not only has each leader had to contend with politics at home, but also with the other leaders. It isn’t smooth sailing, but it makes our ability to come up with fiscal policy or debt ceiling limits look pretty pathetic. As campaign rhetoric heats up, look for our political system to seem even more unworkable than Europe’s (and that’s a high hurdle for unworkability).
- A Central Bank that can be Aggressive with Monetary Policy. Support for QE is running low. We may get it this week. We may get it next meeting, but the enthusiasm for doing it seems to be running out of steam. In Europe, they have just begun. They have LTRO but with OMT and ESM they may well just be starting balance sheet expansion. Our Fed can jawbone about keeping rates low, the ECB can actually cut rates.
- Low Stock Valuations. Most of Europe is below post Lehman highs. The US is now at multi year highs.
The course may change, but I remain bearish in short term, largely on market being overly optimistic of what central banks can do in terms of pushing prices higher from here or improving earnings, but I see more possibility of Europe entering a Q2 2009 moment. That would be very bullish for Europe and might drag us along, or might not.